(CTN News) – India is catching up to China as the largest country in a benchmark emerging-market index, posing a problem for global investors who are becoming more exposed to its thriving but pricey stock market.
Soaring share prices, stock sales, and earnings growth by Indian corporations have propelled India to just under a fifth of the MSCI emerging markets index, while China has dropped to a quarter, down from more than 40% in 2020.
An MSCI index review due for next month could raise India’s weighting to nearly 20%, eclipsing Taiwan and putting India right behind China, according to investors.
The decreasing gap has become one of the most pressing challenges for investors in developing markets this year, as they choose whether to invest in an already hot Indian market or in Chinese stocks, which are comparatively inexpensive but suffering from an economic slowdown.
“The two consensus trades in emerging markets today are ‘long India, short China’,” said Varun Laijawalla, emerging markets portfolio manager at NinetyOne asset management. “The valuation spread between these two markets is as wide as it’s ever been,” he said.
Indian companies are trading at 24 times their estimated earnings for next year, compared to only 10 times in China.
The move has also highlighted the importance of indices in emerging economies, whether by channeling billions of dollars in index-tracking passive flows or encouraging active managers to adjust their exposure to established benchmarks.
“Ten or eleven years ago, India represented 6 to 7 percent of the index. Kunjal Gala, head of global emerging markets at Federated Hermes, said the figure is now close to 20%.
Because Indian stocks are already highly expensive, the index move “poses an interesting dilemma for long-term investors like us, or investors who are more focused on’margin of safety’ valuations.”
“We are slightly underweight India at the moment, not because we don’t like India as a country from a top-down, macro perspective,” but because of the focus on margin of safety or trying to acquire equities at prices considerably lower than their intrinsic worth, Gala explained.
Domestic inflows into equities funds have been critical. From 2016 to 2020, the average annual net domestic flow into equities was $12 billion. Between 2021 and 2023, these annual flows increased to $29 billion, according to Laijawalla.
Despite doubts about the long-term viability of these flows and valuations, investors face the conundrum that missing out on Indian stocks has historically been costly. In recent decades, India has been one of the world’s best-performing markets in local currency terms and has maintained pace with US markets in dollar terms.
According to Vikas Pershad, a portfolio manager at M&G Investments, it has also been the world’s best market for “multi-baggers,” or equities that have increased in value by at least tenfold.
“One of the least relevant financial indicators anywhere, but especially in India, is the one-year forward price-to-earnings ratio,” said Pershad. “This is why, for 20 years, investors have missed out on returns in India.”
According to Bloomberg statistics, consensus forward earnings per share expectations for Indian members in the MSCI emerging markets index are in the mid-teens this year and next, which is consistent with other emerging markets. While Indian companies’ earnings are increasing, they are not outpacing other rising markets.
“The profit growth in India is actually ordinary,” said Sunil Tirumalai, global developing markets strategist at UBS. However, whereas Chinese firm valuations have fallen in recent years, India’s have risen, thanks in part to a surge in retail investments.
Many Indian households are investing in local equities to offset what they perceive as low interest rates, which at best equal official inflation.
Domestic purchases, generally made through automated monthly transfers to funds managed by large banks such as ICICI, have readily countered international institutions’ migration out from India. “Foreign ownership has fallen to an 11-year low,” according to Tirumalai.
“On an aggregate basis, global investors are still underweight India,” says Vivian Lin Thurston, a portfolio manager at William Blair Investment Management, citing valuations. “As the Indian weight is increasing, it gets harder for them to find attractive value stocks in India, or they will need to rethink their valuation metrics.”
Following the expansion of mainland listed businesses in 2019, China’s weighting in the index increased the next year. Even yet, mainland stocks are still not completely represented.
“Historically, when countries reach a 25% weight in the MSCI EM Index, they tend to fall back from their highs,” said Jitania Kandhari, managing director on the emerging markets equity team at Morgan Stanley Investment Management.
Source: Financial Times
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